Should I Pay Off Debt With My Income Tax Refund or Put It in Savings?

Choosing between two great ideas is no easy task. Paying off debt and saving money both have benefits. Evaluate your financial goals and current situation to determine which option is best. While one option may be better for you, you'll be glad to know you have the self-discipline not to blow your refund on something frivolous.

Good vs. Bad Debt

All debts are not equal. Evaluate each of your debts and decide which ones you benefit from. If you've borrowed money so you can make money -- such as a car loan so you can get to work or a home loan that builds equity -- the debt may be worth keeping. However, debt for a vacation you took last year or a pair of shoes you sold at your yard sale last summer should be paid off quickly. If you have debt that is only costing you, it takes priority.

Do the Math

Eliminating debt is a financially smart choice. But you may want to ask yourself some questions to make sure this is better than tucking the money away. For example, evaluate if your job is stable and your amount of savings. If you could lose your job at any time, or if you have nothing saved, savings may be more important for you than paying off debt. Also, find out the interest rates you are paying on your debt. Paying off a card with a zero percent interest rate for the next six months might not make sense. Paying off a card with a 29 percent interest rate does.

Getting Emotional

Make this decision without letting your emotions interfere. It may be tempting to save your tax refund instead of paying off debt simply because a financial cushion can make you feel better. But then you must decide if you can maintain enough discipline to not spend the money you save. Use your tax refund to give you peace of mind long-term, by using it to achieve your financial goals -- whatever they may be.

Save and Reduce

You could get the best of both worlds with a fifty-fifty split. Use half your refund to reduce the debt with the highest interest rate or the debt that you get no new benefit from. Put the other half in savings. Or you could pay off debt and make the payments you no longer have each month to your savings account.

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About the Author

Sara Mahuron specializes in adult/higher education, parenting, budget travel and personal finance. She earned an M.S. in adult/organizational learning and leadership, as well as an Ed.S. in educational leadership, both from the University of Idaho. Mahuron also holds a B.S. in psychology and a B.A. in international studies-business and economics.

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